403(b) Plans: The Flaws Teachers Should Know

It’s no secret that many teachers are underpaid, in spite of the vitally important work they do. I know first hand: my mother was a public school teacher and a single mom. While some teachers may have other assets and savings they can draw on, a great number of teachers will rely on the retirement plans commonly used by teachers, known as 403(b) plans, as a source of income once they retire.

This Is Money Teachers Will Need

In a recent series, The New York Times detailed many issues with the 403(b) plans so critical to a comfortable retirement for teachers. Their first piece, “Think Your Retirement Plan Is Bad? Talk to a Teacher” makes many of the same points we touched on previously in Teachers: Who is Managing Your 403(b)?

As the Times correctly points out: “Teachers in about a dozen states may not qualify for Social Security. And while public school teachers often are offered decent pensions, many of them do not work for the decades required to qualify for a full payout. And pension formulas are becoming less generous for newer recruits.”

Unlike 401(k) plans that are overseen and regulated by federal law based on the Employee Retirement Income Security Act (ERISA) of 1974, many 403(b) plans fall outside of ERISA oversight and protection.

Who Can Teachers Trust?

Instead of having access to a financial advisor who is a fiduciary, someone who exclusively – and always -must have the client’s best interests in mind, teachers are often presented with salespeople from insurance brokers who earn commissions for recommending certain products. As one teacher recounted in part two of the NYT series: “From the teacher’s standpoint, they really miss out getting quality advice,” said Mr. Bergeron, 27, who sold the plans for Axa Advisors’ retirement benefits group. “People who are in the schools pitching them and positioning themselves as retirement specialists are really there just to sell them one product.” (For more, see: An Investor’s Guide to the New Fiduciary Rule.)

Fee-only fiduciary advisors are advisors who only recommend investments that are the best for their clients, not ones that reward themselves. Fiduciary financial advisors aren’t trying to hit a quota or working for sales commissions on the products they recommend to you. Fiduciaries are committed to providing the best advice to investors – like teachers – looking to build a strong foundation. These advisors grow with you, not at your expense by profiting off the products they recommend to you.

Many of the millions of employees in this country have access to 401(k) plans through their employer that are approved and monitored by the employer in some way, ensuring at least some oversight of the plan itself. Unfortunately, public school teachers as well as some teachers working for nonprofits and religious institutions are easy prey for companies trying to sell high-cost products because their retirement plans often don’t have the same oversight. Given the loosely regulated industry, the insurance salespeople or “advisors” pitching to teachers can recommend investment products that best for their own pockets, not the plan owners’.

The Costs and Confusion

While 401(k) plans are not perfect either, as we have pointed out before, the majority of them offer more traditional investment options, such as mutual funds or stocks and bonds, making it easier to understand how your money is invested. In contrast, 403(b) plans are often held inside annuities, which can be confusing even for the most intelligent individual investors. Discussing Axa Advisors, a broker that often tries to sell annuities, The New York Times writes: “The most popular version of the Equi-Vest annuity has a total annual cost that can range from 1.81 to 2.63%, according to an analysis from Morningstar. In contrast, large 401(k) plans usually charge an annual fee of less than half a percent of assets, according to a May report by BrightScope using 2013 data.”

Even if teacher realizes that they are paying excessive costs for their retirement investments, they are often locked into these annuities and required to pay a penalty if they want to make changes. If a teacher wants to transfer their assets out of the Axa Equi-Vest annuity into their own IRA, for example, they would have to pay a 5% penalty on the portion of that withdrawal that had been contributed within the last six years.

One of — if not the biggest — advantage of many retirement plans is tax deferral, which allows these accounts to grow and compound over a long time horizon. That ability to grown and earn compound interest is obviously compromised when you are paying excessive fees year over year.

Teachers are one of our most important assets and deserve to be rewarded for their years of dedication to our country’s children, and therefore our country’s future. All too frequently, however, teachers not given access to solid, low-cost and efficient long-term investment options in their retirement plans. Nor are they given access to a financial advisor they can turn to with questions, knowing that they can trust the answers they are given.

We encourage teachers to spend some time finding out more about their 403(b) retirement fund managers. It’s vital to find out whether they are a fiduciary, how they make money (fee-based or fee-only), and how personalized their investment strategy is. (For more, see: 6 Questions to Ask a Financial Advisor.)

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